David RosenbergPeter Power/The Globe and Mail
Well, that old adage about every bull market needing to constantly climb a wall of worry could scarcely be more the case than it is this week.
No sooner do we manage to get the Greece file behind us than we face the intensifying macro, financial and policy instability in China, the spreading market and currency weakness throughout the once-hot emerging market space and this latest and most pernicious leg of the downcycle in oil and industrial commodity prices, taking the Canadian dollar into a new and lower range in the process.
Now, I want to emphasize that it has been four years since we last experienced a serious correction. Usually, even in the context of secular bull markets, corrective phases that help the market rid itself of speculative or overvalued excess tend to occur every 12 to 18 months, not 70.
So in some sense, we were long overdue and valuations stretched enough that it wouldn't have taken much to elicit a temporary pullback, which is what this has been – the reality is that corrections are typically severe but swift; they are part and parcel of the investment process even if they are a nuisance.
What is interesting is that this sell-off is taking hold just as revisions over the U.S. economy are improving – believe me, in an era in which productivity and demographic challenges means that potential is little better than 1.5 per cent or 2 per cent, a 3-per-cent GDP growth rate (which is looking increasingly to be the case for Q2 and Q3) really means something.
The challenge for the stock market is that while most of GDP is local, much of the stock market is global and the fact that Beijing ratified its first devaluation since 1994, no matter how small, has the markets thinking that the economy is doing far worse there than anyone had thought.
There's probably some truth to that, no doubt, and today's easing moves by the People's Bank of China shows that the policy-makers there recognize that the economy is dramatically underperforming expectations. At the same time, I think we have to keep in mind that if there is a central bank on the planet with the room to still ease monetary policy, it is China, and there is also room to stimulate via fiscal policy as well.
So, five observations to make:
1. To reiterate, we went four years without a major correction for the market as a whole (the third-longest stretch ever) – so everything that is happening should be viewed in that context.
2. This latest corrective phase began with China, and is likely going to have to end with China – there is no ability for the Fed to pull a rabbit out of its hat as it did in 2010, 2011 and 2012. The best it can do is nothing, and so the good news is that the Fed is now probably going to delay its rate-hiking cycle.
3. The secular bull market is not over, even if the unusual characteristic that was the powerful driver for price-to-earnings expansion is probably over – namely, the power of zero rates and central bank and government ability to distort or manipulate the markets. We are seeing in real time that there is a limit to how far valuations can rise via ultralow rates and intervention alone and this isn't necessarily a bad thing at all.
4. All this points to greater volatility, lower expected returns than in the past and, most important, as we have seen already, a greater dispersion of performance – while a multiple beta-driven market suits a "passive" investment style, the new environment we will be confronting even after the dust settles is an earnings-driven market, which means that stock selection and "active" investment management will be paramount.
5. All the paranoia and fear-mongering calls for the end to the bull market have been proven wrong time and again – I can't emphasize enough that this only switches from a plain-vanilla correction to an outright bear market if Big Daddy – the U.S. economy – slips into a downturn.
So heading into Tuesday, we had hit a washout point where the baby gets thrown out with the bathwater. It's one thing to have large cap global names exposed to China and emerging markets correct hard, but we had a situation at Monday's close in which sectors such as telecom, retailers, home builders and regional banks sold off sharply and yet they have absolutely nothing to do with what's happening beyond U.S. borders.
If 30 years in this business has taught me anything, it is that panic selling eventually yields to opportunity. And while it may still be early, there are places across the world and across the capital structure where things are getting cheap just enough to start warranting a good, hard look, especially in the areas that are hitched to this $15-billion beast otherwise known as U.S. domestic demand, notably housing, autos, financials and consumer cyclical services where the fundamentals are the most constructive.